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Cost allocation in manufacturing-remanufacturing operations

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In many firms, manufacturing and remanufacturing operations are carried out in different divisions whose managers' performance is evaluated on an individual basis. In this research, the authors expose the decision-making inefficiencies in such a structure, and propose a mechanism to align incentives. To this end, they consider a manufacturer who also undertakes remanufacturing operations. In a two-period model, they characterize the global profit-maximizing prices of the two products. The authors show that if the same decisions are delegated to managers whose goal is to maximize divisional profits, their decisions would be sub-optimal. They then find a mechanism that achieves optimalitv in a decentralized system with two self-interested decision-makers who are responsible for the two processes, respectively. This mechanism is a cost allocation mechanism that allocates a proportion of the initial production cost of the product to each of the two stages of the product life cycle. Their results provide several recommendations that can assist in coordinating the manufacturing and remanufacturing operations in a firm.